What is a Recession & When is the Next One?

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What is a Recession & When is the Next One - Ultimate Guide Article Header

Summary: In this article, we will answer the question, “What is a recession?” Topics also include causes of a recession and the five key indicators to look at, the difference between a recession vs depression and will there be a recession in 2020? Read on to learn more.

Introduction

Wondering when the  next recession will hit? You’re not alone. A lot of people today are asking the same questions. Unfortunately, we can’t see the future. What we can do is learn from the past. In this article we’ll take a look back at what happened in 2008. We’ll also highlight five recession indicators, how these indicators impact the economy and help us predict when the next recession will occur. 

Remember that recessions are a necessary part of the ever-expanding and contracting economic cycle. A recession can be a planning opportunity for consumers and investors alike. Regardless of when the next recession will hit, there are ways to prepare for the economy in 2020 and beyond.


What is a Recession?

A recession is when the economy declines significantly for at least six months. A drop in the following five economic indicators occurs during a recession: 1) real gross domestic product, 2) income, 3) employment, 4) manufacturing, and 5) retail sales. 

Image defining What is a Recession

As defined by the National Bureau of Economic Research, a recession is “a period of falling economic activity spread across the economy, lasting more than a few months.” The NBER indicates the start and stop of recessions and is the national source for measuring stages of the economic cycle. 

Rather than basing a recession strictly off numbers, the NBER relies on skill, expertise and judgement. As the official arbiter of economic growth and decline, economic leaders and Nobel Prize winners make up NBER’s board, with more than 1,300 economists and business professors who perform its research. 

Professor of economics at the University of Michigan and former member of the White House Council of Economic Advisers, Betsey Stevenson explains, “Recessions come in all shapes and sizes. Some are long, some are short. Some create lasting damage, while some are quickly forgotten. And some touch virtually all parts of the economy, while others are more targeted.”

When economic growth returns, this indicates the end of a recession. However, if often takes some time for the bureau and society to recognize it.


What Causes a Recession?

Recessions can be triggered by shrinking businesses, a cluster of business errors coming to fruition simultaneously or inflation. Because a recession isn’t caused by one single indicator, but a culmination of indicators, it’s important to understand how one impacts another. 

 A High Inflation Rate

When an economy falls into a recession, one of the main causes is inflation. Inflation is a general rise in the prices of goods and services over a period of time. Simply put, a high inflation rate makes the same amount of goods and services more expensive. 

Inflation can occur with increased production costs, higher energy costs and national debt. When inflation rates are high, it affects the overall spending of consumers and businesses. People tend to cut down on “leisure” spending, spend less overall and start to save more. 

With consumers and businesses cutting expenses and trimming costs, GDP begins to drop and unemployment rates go up. A combination of these factors creates a domino effect and can cause the economy to drop into a recession. 

The best way to know what causes a recession is by understanding the five recession indicators and how their performance affects all other indicators. 


5 Recession Indicators

Experts refer to five economic indicators when determining the overall health of the national economy. 

Image highlighting 5 Recession Indicators

1 – Real Gross Domestic Product (GDP)

The GDP is the most important indicator of a recession. Real Gross Domestic Product refers to everything produced or made by businesses and individuals in the United States, not including inflation

If a GDP growth rate turns negative, this may be an indicator of a recession. However, growth may be negative throughout one quarter and bounce back to positive during the next quarter. 

Because it’s difficult to determine a recession based on GDP alone, NBER measures monthly indicators. When each of these indicators declines, so will GDP. 

2 – Personal Income

Real personal income is adjusted for inflation and does not include transfer payments like Social Security and welfare. A decrease in personal income is a result of businesses reacting or adapting to a changing economic climate in order to remain profitable, or just to stay afloat. One of the first things a company is going to do in order to save money is to lay off employees or cut their pay. When real income goes down, so do consumer purchases and demand, while unemployment rates go up.

3 – Employment

Monthly job reports, also called “Employment Situation Summary” and “Non-Farm Payroll Report” are used to measure employment health. The data in these reports is gathered and released by the Bureau of Labor Statistics at the beginning of each month. 

Not only is the Employment Situation Summary the first report released every month, it’s the most comprehensive and credible, making employment a key economic indicator. The report also includes the unemployment rate for the month. 

Additionally, the Department of Labor provides a weekly jobless claims report. This report measures the number of claims for unemployment benefits from each state. The information in this report is valuable because 1) it provides an indication of trends (an increase or decrease of unemployed), and 2) it’s released weekly, which provides a more frequent indicator of trends in between monthly job reports.

As noted above, an inflated economy can result in a rise in unemployment rates as businesses lay off workers in order to reduce costs. 

4 – Manufacturing or Industrial Production

With U.S. manufacturing owning the largest chunk of the global industry, producing 18% of the world’s goods, it’s easy to see how important it is to the economy. A critical part of gross domestic product (GDP), manufactured goods make up half of U.S. exports, adding tons of value to the overall economy. 

The Industrial Production Report measures the health of the manufacturing industry. Manufacturing in the U.S. refers to a process that is physical, mechanical, or chemical, transforming raw materials into new products. 

Examples of manufacturing businesses include, factories, mills, and plants, making products using machines and equipment. Manufacturers also includes smaller businesses that make products by hand, such as custom tailors, bakeries, and candy stores.

For every dollar spent in manufacturing, $1.89 is added to growth in other industries, including transportation, retail, and business services. Which leads us to our next recession indicator… 

5 – Wholesale-Retail Sales

Retail sales is the purchase of finished goods and services by consumers and businesses. The supply chain contains four links starting with the goods producer and ending with the retailer: 

  1. The goods producer provides commodities and other raw materials
  2. Manufacturers make the product
  3. Wholesalers distribute the goods or services to retailers
  4. Retailers sell goods or services to the consumer

The retail sales report is also released monthly by the U.S. Census Bureau and measures the U.S. retail industry. The report shows total sales, percent change and change in year-over-year sales. Keep in mind that the report is not adjusted for inflation and may be misleading depending on the time of year and consumer demand.

For instance, gas and oil prices generally increase in the spring and summer, with people going on trips and driving more. This causes a jump in retail sales during these months, and then a sudden drop in the fall. 

Retail sales show us how much demand there is for consumer goods. Consumer spending makes up nearly 70 percent of total U.S. economic output. This makes wholesale/retail sales a critical indicator of overall economic health. 

Please note that the health of the stock market does not indicate a recession. Rather, stock prices show the expected earnings of public companies. During a recession, the stock market enters what’s called a “bear market” or 20% decline. However, a crash in the stock market can cause a recession as many investors lose confidence in the economy and pull their money out.

Recession vs Depression

While a recession can turn into a depression, there’s a notable difference between the two. As mentioned, a recession occurs when the economy contracts or drops for two or more quarters (six months). A depression, on the other hand, will last several years. 

For example, unemployment can rise to 10% during a recession. During the Great Depression (from 1929 to 1939), unemployment peaked at 25%. 


Are There Any Benefits of a Recession?

Image highlighting Benefits of a Recession

The goal of the Federal Reserve is to keep a balance between slowing the economy enough to prevent inflation without causing a recession. But are there really any benefits of a recession? In the following sections, we’ll explain the one major benefits of a recession, along with some silver lining when it hits. 

Recessions Cure Inflation

The one major benefit of a recession is that it cures inflation. When inflation is too high, the Feds will usually increase interest rates, in an attempt to slow down the economy and lower inflation. Keeping inflation low benefits everyone.

A Recession is Always Followed By a Recovery

While we may not be able to predict exactly when the next recession will occur, we do know that it’s always followed by a recovery. That recovery includes a strong stock market comeback. 

The last Great Recession ended in 2009, after devastating the investments of a massive amount of people. Had the majority not panicked and held onto these investments, they would have seen a full recovery, plus an increase in value. The best way to weather a recession is to put your money into long-term investments, as the economy will eventually even out.


Will There Be a Recession in 2020?

The first sign of an imminent recession comes from a drop in one of the five leading economic indicators. Thus creating a snowball effect for the other key indicators. 

In a recent webinar hosted by our own, Kathy Fettke, Co-Founder and Co-CEO of RealWealth, she discusses the question: Will there be a recession in 2020? The webinar also features long-time real estate developer Fred Bates and highlights his take on the current economy and whether to expect a recession in 2020. Here’s an overview of what was discussed:

Media Induced Recession Fears

The word recession triggers fear in the minds of many Americans. This is understandable, as we only experienced one of the greatest recessions in history just 10 years ago. However, Fettke and Bates both share the same sentiment that the media loves to play on emotions of fear. It’s the sensational news that affects those fears the most, even though we’ve experienced a relatively steady economy since 2010.

Rather than basing investment decisions on emotion-provoking news articles like, “Housing Crisis” or “Impending Recession”, Bates simply looks at the data. His expert opinion is that the economy looks good for the next five to six years. 

Data Tells the Story

According to Bates, the data shows that the housing market is booming. We’re seeing a record high stock market, real estate prices reaching historical highs, unemployment nearing historical lows, interest rates and inflation remaining low, and income at historical highs. We’ve never been in this situation, especially where we have low interest rates and low inflation. 

For Bates, this is the environment investors have been looking for. He says, “If we want to paint the perfect economic picture, this is it. Yet, some people are looking for faults in it. We’ve never been in a situation like we’re in now. But wading into unchartered water can add fear to consumers.”

The Economy and Real Estate Climate

Real estate over the long haul is going to appreciate. Most of the reaction to this type of uncertainty was led by the Feds raising the interest rates in 2018. In 2019, there has been more of a rejuvenation for single-family homebuilders. The lowering of interest rates have made it more affordable and possible for people to buy homes. 

Additionally, the lack of supply for new housing is low by historical levels. The U.S. is not keeping up with demand for single-family homes. We are continuing to see a higher demand and a lower ability to meet the demand because it can be difficult to buy lots to develop.


What You Need To Know About the 2020 Economy

I had the opportunity to sit down with Co-CEO of RealWealth, Kathy Fettke, who’s an expert on this subject. She explained that we’ve been seeing a lot of volatility in the global economy these past few months as well as headlines warning us about all sorts of economic uncertainties, like the trade dispute, a worldwide economic slowdown, and geopolitical issues. She mentioned that it’s been enough to upset the stock market, so I asked her if real estate investors should be concerned.

What I learned was that constant headlines about an impending recession can actually cause a self-fulfilling prophecy, because confused consumers and investors might actually start pulling back their spending and start saving. This is especially true for anyone who experienced losses during the Great Recession of 2008. Nobody wants a repeat of that nightmare situation.

One thing Kathy made clear was that the real estate market is very different today than it was a decade ago. Here are a few reasons why… 

How the 2020 Real Estate Market Differs From 2008

Image highlighting How the 2020 Real Estate Market Differs From 2008

1 – Mortgage Loans are Solid

Many of us remember how easy it was 10 years ago to qualify for home loans. In 2007 and 2008, adjustable rate mortgages began resetting to higher rates making it impossible for homeowners to afford their new mortgage payments. This resulted in people defaulting on their mortgages and subsequently, millions of foreclosures across the nation.

Back in the early 2000’s, subprime loans were abundant. That is not the case today.

Qualifying for a mortgage loan today is much more difficult than it was 10 years ago. First-time homebuyers must have a high credit score, low debt-to-income ratios, proof of their ability to afford the mortgage payment with a two-year job history and cash reserves in the bank.

As such, we’re seeing the effects of raising the standards to qualify for a mortgage. In Q2 of this year, single family residential mortgage delinquencies hit a record low of 2.59%, down from 11.54% in 2010, According to the St. Louis Fed.

Just this year, new regulations have made it even more difficult to qualify for a mortgage. In March, the FHA is now requiring even more stringent standards to applicants with high debt and low FICO scores.

2 – Home Equity is at an All-time High

Owner equity in real estate has hit new highs. In fact, home equity has more than doubled in just 7 years. 

“Tappable” equity (equity that homeowners can borrow against) reached an all-time high this year, with a 26% increase since the last peak in 2006, according to Black Knight. 

With fixed-rate monthly mortgage rates and a good amount of home equity, even if there is a recession, it’s much less likely that borrowers will be forced to walk away from their homes.

If you are waiting for the next foreclosure crisis so that you can cash in on underpriced, distressed homes, you may be sitting on the sidelines for awhile.

3 – There’s Not Enough Housing Supply to Meet Demand

The U.S. population has grown by over 25 million people since 2008 and household growth has increased by 10 million. Because home builders took a major hit during the last recession they have been slow to come back and unable to keep up with demand.

Contributing to the lack of supply, short-term rental business is booming, when it did not exist in 2008. According to Reuters, approximately 600,000 homes are now being used as short-term rentals. This new business has effectively taken long-term residential units off the market.

According to Freddie Mac’s website, “If supply continues to fall short of demand, home prices and rents are likely to outpace income and household formation will fail to reach potential.”

When interest rates increased last year, housing inventory levels began to grow. At that time, news stations were reporting a “housing slump,” when in reality the market was balancing out.

Home sales spiked this past summer when interest rates started to decline. Now, housing supply is down by as much as 10% for affordable, new homes priced under $200,000.

Robert Dietz, chief economist of the National Association of Home Builders, says, “It’s not just the overall supply of new construction that’s gone down, but the supply of starter homes. So it’s the affordability challenge at the entry level that’s been a particular challenge.” 

With the high cost of construction, developers are building more expensive homes. However, this is the home category with the most supply. Inventory levels for homes between $200,000 and $750,000 is flat and starting to decline. 

4 – There’s a Lack of Affordability

Today’s low interest rates will help more people buy a home before the end of the year, and probably into 2020. But it’s important to understand that there is an affordability ceiling. 

Home prices can’t rise forever, no matter how low interest rates go. Rents can’t climb forever either. 

To Recap:

Based on what we learned above, the theme of 2020 will most likely be a “Slowing but Growing Economy.” Expect to see growth, but it will likely be slower than the past decade. 

New supply of homes will be slow to market. Sales will be strong in affordable housing, moderate in median priced homes and slow in high priced property.

The current real estate cycle is ending, and we are entering a new cycle of “normal” and “stable.” However, we are certainly not entering a “housing crisis”.


Conclusion

The first step to preparing for the economy in 2020 is understanding what a recession is, along with its causes and effects. The five economic indicators will give consumers and investors a good idea of when the next recession is coming and how to be ready when it does hit. 

If you are keeping money on the sidelines waiting for the next housing crash, you may never get to play the game. If you play the game, focus on fundamentals.



Sources:

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